Feb 28, 2018 08:20 PM

Liu He: Lessons From Global Economic Crises (Part 2)

Editor’s note: The international economic and financial communities have only recently gotten to know Liu He, after he became China’s top representative at the World Economic Forum in Davos, Switzerland in January, where he talked about China’s plans to further open its financial sector this year.

Now in Washington on a mission to defuse growing China-U.S. trade tensions, the key economic aide to President Xi Jinping and one of 25 top decision-makers in the Politburo of the ruling Communist Party is believed to be a rising star on China’s political and economic fronts. Observers say he is likely to be promoted to a key government position at the National People’s Congress in March to take care of the many tricky issues facing the country’s economy and financial system.

Although the 66-year-old is only now stepping into the global spotlight, he has a long-standing reputation at home as an influential economist and policy adviser.

Among the many research papers Liu has published over the years, one of his most renowned works was “Comparative Study of the Two Global Crises” in 2012, which analyzed the common characteristics and lessons for policymakers of the Great Depression, which started in 1929, and the global financial crisis that began in 2008.

In the aftermath of both crises, Liu wrote, governments faced three major challenges — populism, nationalism and economic problems that were identified with certain political values or ideologies.

Liu also put forward measures for Chinese policymakers to deal with any future crisis: preparing for the worst possible scenario; grasping strategic post-crisis opportunities to drive global economic recovery; and prioritizing the domestic economy when implementing policy to deal with a crisis.

Liu’s paper was published in Comparative Studies, a bimonthly journal produced by Caixin Media and Citic Press Group that focuses on research juxtaposing economic and social issues and policies in China and other countries. His analysis gained recognition, and in 2014 it won the Sun Yefang Economic Science Award. Named after distinguished Chinese economist Sun Yefang, it is the country’s highest honor in the economics field and is given for outstanding contributions to economic science that promote the prosperity and development of China.

Caixin is publishing a two-part series of translated excerpts from the second, third and fourth chapters of Liu’s paper, which offer valuable insights into China’s policymaking in terms of domestic reform and the government’s battle to defuse risks in the financial system. They also shed light on China’s approach to international issues such as bilateral economic and trade conflicts. Part 1 was published on Tuesday, Part 2 follows below.

Similarities between the two crises

In general, financial and economic crises are inherent features of the capitalist system — since the Industrial Revolution such crises have occurred frequently in capitalist economies. The Great Depression in the 1930s and the Global Financial Crisis that began in 2008 had the biggest and most disruptive impact on the world and both took place when problems in the capitalist system had accumulated to a point where they could not self-correct.

5. In the run-up to both crises, speculation became extreme and people bought into the belief they could go from rags to riches overnight

The industrial growth and widening disparity in wealth and income distribution that preceded the two crises distorted social psychology in capitalist economies. People were easily taken in by stories of speculative miracles, and man’s natural instincts of greed and amnesia reached unprecedented levels. In a loose monetary environment compounded by higher leverage ratios driven by financial innovation, many people used borrowed money to engage in high-risk speculation that created huge asset bubbles — equity bubbles before the Great Depression and real-estate bubbles before the 2008 crisis. There is no doubt that at specific periods in time and under certain institutional conditions, irrational behavior and the power of self-delusion are significant factors that can lead to a crisis.

6. Both crises were linked to monetary policy

Prior to both crises, governments had adopted easy monetary and credit policies. While a deluge of credit before the Great Depression fueled equity bubbles and speculative fever, the U.S. Federal Reserve’s extremely loose monetary policy, lax financial supervision, and subprime mortgage lending pumped up the bubble in the run-up to the 2008 crisis.

7. After both crises erupted, decision-makers faced three major challenges that exacerbated the problems: populism, nationalism and politicization of economic issues

In both crises, governments made the same mistakes and took the wrong action. They applied austerity measures when proactive macroeconomic policies were required, became protectionist when opening up and international cooperation were needed, and failed to press ahead with, or even backtracked on, necessary policies such as cutting social welfare and implementing structural reforms. With the benefit of hindsight these mistakes look ridiculous, but for those in office at the time, implementing the right policies was arduous. Under pressure from populism, narrow-minded nationalism and the politicization of economic issues, inexperienced politicians were held hostage by short-term public opinion and were not brave enough to break free from the straitjacket of politics and ideology.

8. Crises follow a certain path and must be allowed to run their course before economic recovery can take place

Crises often begin with a sharp economic downturn. The bursting of bubbles leads to higher unemployment; deepening economic problems aggravate social conflict; and economic and social conflict can spread to the political and even military spheres. Faced with excessively high debt, governments are forced to undertake fiscal tightening, restructure their debts and devalue their currencies to deal with the economic pressure resulting from the bursting of bubbles. But before the economy starts to recover, inflation rises and the stock market booms, building a false hope of economic recovery that is soon dashed.

9. In the depths of a crisis, solutions emerge that represent major breakthroughs in economic theory

In the aftermath of the Great Depression, a world in despair embraced Keynesian economics. Although Keynesian economic theory came back into vogue during the 2008 financial crisis, the potential decline in productivity threatened by aging populations, global overcapacity and deepening constraints on resources, coupled with a more “sticky” labor market, has put limitations on policies aimed at simply expanding aggregate demand. In addition, the negative effects of global deflationary pressures and the worsening European sovereign debt crisis have once again thrown the global economy in a very difficult and complex situation. The proliferation of research combining psychology, economics and political science and the growing interest in state capitalism are gaining attention, indicating that the world is searching anew for a breakthrough in economic theory.

10. Crises have strong redistribution effects that lead to a shift in the balance of power among great nations and bring about change in the international economic order.

In his book “Diplomacy,” former U.S. National Security Advisor and Secretary of State Henry Kissinger posits that that a new global power emerges every 100 years and the two crises support this assessment. After the Great Depression, the center of gravity of the world economy shifted from Europe to the U.S. and led to major changes in the world’s economic and political structure. The U.S. became the most powerful economy, the dollar became the dominant currency, and the United Nations, International Monetary Fund and World Bank all came into being. After the 2008 financial crisis, the focus of global development shifted to the Asia-Pacific region, the Group of 20 (G20) emerged as a platform, the comparative strengths of nations is undergoing profound change and the international economic order is changing. The 2008 financial crisis not only had the negative effect of destroying productivity growth, it also had the positive effect of driving innovation and creating a stronger redistribution effect.

In short, great crises not only lead to redistribution of wealth within a country, but also to a redistribution of strength among nations. These redistributive effects are inevitable and the world economic order will continue to undergo steady but irreversible change.

Three policy recommendations

Comparative research outcomes and the rapid deterioration of the European debt crisis tell us we must be prepared for the worst-case scenario in the event of a crisis but must still strive to optimize outcomes. We have to be able to respond to unexpected external shocks but also make long-term preparations to cope with structural changes. Only by doing so can we put ourselves in an unassailable position.

There are two scenarios that we must guard against. First, the turbulence that results from a rapidly spreading crisis, and second, the possibility that some countries may resort to military conflict to deflect from their domestic crisis. Although the likelihood of these scenarios playing out in the short term is low, we still need to take preventive measures.

1. China should seize the strategic opportunities thrown up by the changing global economic tide and seek out areas where our interests and those of the rest of the world converge. From an economic point of view, before the 2008 global financial crisis, China’s strategic opportunity lay in expanding its international markets and inflows of international capital. We seized that opportunity and became the manufacturing center of the world.

2. In the post-financial-crisis era, as major economies around the globe enter a long period of weak demand and deleveraging, we now have the opportunity to acquire technology and invest in infrastructure in developed countries as well as use our domestic market to give traction to the global economic recovery. We need to firmly grasp these substantive changes, seriously study and research the immense intersection of interests that has emerged between our country and other great nations under these new conditions, put forward clear proposals to solve the growth predicament facing the global economy and implement them as external conditions stabilize.

3. Comparative research outcomes also teach us that no matter how fast the global environment changes, we need to focus on putting our domestic affairs in order. This is a fundamental strategy that will allow us to cope with external shocks and achieve our peaceful rise. We need to draw lessons from the rise of other nations, guard against getting involved in global affairs that don’t concern China, and focus on improving the way we handle our own affairs.

Translated by Leng Cheng ( and Pan Che (

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